October 31, 2011

Is Income Inequality a 'Myth'?

Pay no attention to soaring executive compensation, or Wall Street bonuses, or even to the latest CBO report on income distribution: skyrocketing income inequality the past few decades is just a “myth”—at least according to Jim Pethokoukis of the American Enterprise Institute. In a recent post on AEI’s Enterprise blog, Pethokoukis contends that the data liberals typically tout on inequality understates key factors like median income gains, discounts the effects of taxes and benefits, and ignores the differing inflation rates on goods that different income groups purchase. At first glance, Pethokoukis’s case sounds sober and reasonable enough. But according to the experts I interviewed, it suffers from the defect of having a tenuous relationship with reality.

On the question of inequality, one of the key observations over the last several decades has been the decoupling of labor productivity from median incomes. In other words, since the late 1970s most workers haven’t shared the gains of their labor like they once did, while incomes for the top 1 percent have raced ahead to unheard of levels. What explains these twin trends remains highly contentious; possible factors include globalization, winner-take-all dynamics, a rising education premium, the decline of unions, financial deregulation, and tax policy. (Tim Noah’s forthcoming book is all about that.) But the trends themselves are clear. As Jared Bernstein, a senior fellow at the Center on Budget and Policy Priorities and the former chief economist to Vice-President Biden, told me, “the highest quality data that we have all show the same thing: significant increases in inequality.”

So how can some conservatives like Pethokoukis claim otherwise? One reason is that academics are still refining their understanding of the data. These refinements haven’t undermined the overall narrative, that inequality is increasing. But they’ve challenged many basic assumptions in a way that some conservatives have tried to exploit.

Consider the research and writing of Robert Gordon, a professor of social sciences at Northwestern University. He’s has done pioneering work questioning the extent of the aforementioned gap between productivity and median wages—work that Pethokoukis misappropriates to claim that income gains have been shared “fairly equally.” Gordon found that the productivity gap may be about a tenth the size as what is commonly thought, but, as he told me, that doesn’t negate the story about runaway wealth at the top of the income distribution. “The evidence on the long-term increase of inequality within the bottom 99 percent is ambiguous and complex, but what stands out like a searchlight is the unprecedented and increasing inequality between the bottom 99 percent and the top 1 percent,” Gordon told me.

Pethokoukis’s case seems even weaker when he disputes the notion that after-inflation median incomes have stagnated over the last 30 years. To make his case, Pethokoukis cites a pairof studies from the Federal Reserve Bank of Minneapolis that “nobody took seriously at the time, and they shouldn’t do so now,” according to Bernstein. These papers purported to show that real median incomes had increased more than was commonly believed by employing an alternate, lower price index to calculate after-inflation incomes. Bernstein told me it was a classic case of “plugging things in to get the result you want.”

Pethokoukis thinks that a more thorough accounting for taxes and benefits like healthcare or pensions yield a different picture of inequality. And that is somewhat true. After-tax inequality is certainly smaller than pre-tax inequality. But it is not as true as it used to be. The CBO recently confirmed that federal taxes and transfers are less redistributive now than they were in 1979. The same is true for benefits. As companies have moved towards defined contribution plans and shed healthcare obligations, it’s often been the case that “lower income people don’t get benefits, or their benefits are inferior,” as Bernstein told me. It’s unclear how much tax cuts weighted towards the wealthy and declining middle-class benefits have exacerbated inequality, but it’s a bit odd to cite those factors as reasons not to worry about historic income disparities.

Neither does it make much sense to focus on consumption inequality. Conservatives often point to the fact that despite massive income inequality, there hasn’t been an equal gap in what different income groups spend. This is true. Of course, it ignores that the last decade saw an epochal credit bubble that facilitated this spending. And that is over now. As a corollary, conservatives argue that inflation on lower-income goods is lower than for higher-income goods. Again, true. But again, it’s not obvious why this should mitigate concern about inequality considering that the effect is likely muted.

Strip away all of these shaky arguments and you’re left with the more familiar reality, the one last week’s report from the Congressional Budget Office confirmed: Since 1979, incomes for the broader middle class increased 40 percent, while the top one percent shot up a staggering 275 percent. Conservatives can pretend otherwise, but the numbers won’t.